STEP UP ON SECOND STREET, INC. CONSOLIDATED FINANCIAL STATEMENTS AND SINGLE AUDIT REPORTS

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1 CONSOLIDATED FINANCIAL STATEMENTS AND SINGLE AUDIT REPORTS

2 TABLE OF CONTENTS INDEPENDENT AUDITOR'S REPORT 1-2 CONSOLIDATED FINANCIAL STATEMENTS Page Consolidated Statement of Financial Position 3-4 Consolidated Statement of Activities 5 Consolidated Statement of Functional Expenses 6 Consolidated Statement of Cash Flows 7-8 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 9-25 CONSOLIDATING INFORMATION Independent Auditor's Report on Consolidating Information 27 Consolidating Statements of Financial Position Consolidating Statements of Activities SINGLE AUDIT REPORTS AND SCHEDULES Independent Auditor's Report on Internal Control over Financial Reporting and on Compliance and Other Matters Based on an Audit of Financial Statements Performed in Accordance with Government Auditing Standards Independent Auditor's Report on Compliance for Each Major Program and on Internal Control over Compliance Required by the Uniform Guidance Schedule of Expenditures of Federal Awards 38 Notes to the Schedule of Expenditures of Federal Awards 39 Schedule of Findings and Questioned Costs Corrective Action Plan Summary Schedule of Prior Audit Findings 47-49

3 INDEPENDENT AUDITOR'S REPORT Board of Directors STEP UP ON SECOND STREET, INC. Santa Monica, California We have audited the accompanying consolidated financial statements of Step Up On Second Street, Inc. (the "Organization"), which comprise the consolidated statement of financial position as of June 30, 2016, and the related consolidated statements of activities, functional expenses, and cash flows for the year then ended, and the related notes to the consolidated financial statements. Management's Responsibility for the Consolidated Financial Statements Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP"); this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of consolidated financial statements that are free from material misstatement, whether due to fraud or error. Auditor's Responsibility Our responsibility is to express an opinion on these consolidated financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the U.S. ("U.S. GAAS") and the standards applicable to financial audits contained in Government Auditing Standards, issued by the Comptroller General of the U.S. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on the auditor's judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the Organization's preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Organization's internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. Opinion In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Step Up On Second Street, Inc. as of June 30, 2016, and the changes in its net assets and its cash flows for the year then ended in accordance with U.S. GAAP. 1

4 Other Reporting Required by Government Auditing Standards In accordance with Government Auditing Standards, we have also issued our report dated March 29, 2017, on our consideration of the Organization's internal control over financial reporting and on our tests of its compliance with certain provisions of laws, regulations, contracts, and grant agreements and other matters. The purpose of that report is to describe the scope of our testing of internal control over financial reporting and compliance and the results of that testing, and not to provide an opinion on internal control over financial reporting or on compliance. That report is an integral part of an audit performed in accordance with Government Auditing Standards in considering the Organization's internal control over financial reporting and compliance. March 29, 2017 Armanino LLP Los Angeles, California 2

5 CONSOLIDATED STATEMENT OF FINANCIAL POSITION JUNE 30, 2016 ASSETS Current Assets Cash and cash equivalents $ 1,480,619 Accounts receivable, net 1,507,890 Prepaid expenses and other current assets 32,343 3,020,852 Other Assets Restricted deposits and funded reserves 463,896 Notes receivable from unconsolidated related parties 1,983,484 Investments in unconsolidated limited partnerships 776,449 Property and equipment, net 14,309,652 Deferred financing costs, net 617 Deposits 84,069 17,618,167 $ 20,639,019 See accompanying notes to the consolidated financial statements. 3

6 CONSOLIDATED STATEMENT OF FINANCIAL POSITION JUNE 30, 2016 LIABILITIES AND NET ASSETS Current Liabilities Accounts payable and accrued expenses $ 940,200 Deferred revenue 813,904 DMH liability 313,669 Accrued unemployment 133,357 2,201,130 Long-Term Liabilities Long-term debt, net of current portion 5,353,894 Tenant security deposit liabilities 48,108 5,402,002 Total Liabilities 7,603,132 Commitments and Contingencies (Notes 11 and 12) Net Assets Unrestricted 1,018,092 Temporarily restricted 12,017,795 Total Net Assets 13,035,887 $ 20,639,019 See accompanying notes to the consolidated financial statements. 4

7 CONSOLIDATED STATEMENT OF ACTIVITIES Unrestricted Temporarily Restricted Total Public Support and Revenue Contracts and grants, net $ 8,689,694 $ 215,000 $ 8,904,694 Housing grant - 4,300,000 4,300,000 Contributions 696, ,000 1,151,238 Rental income 686, ,537 Miscellaneous 217, ,680 DMH adjustment to closed contract years (276,845) - (276,845) Equity in income of unconsolidated limited partnerships 1,222-1,222 Net Assets Released from Restrictions 614,917 (614,917) - 10,629,443 4,355,083 14,984,526 Functional Expenses Program services 8,896,436-8,896,436 Management and general 1,472,777-1,472,777 Fundraising 615, ,469 10,984,682-10,984,682 Changes in Net Assets from Operations (355,239) 4,355,083 3,999,844 Other Changes in Net Assets Investment income, net of fees 65,870-65,870 Insurance recovery 44,855-44,855 Total Other Changes in Net Assets 110, ,725 Changes in Net Assets (244,514) 4,355,083 4,110,569 Net Assets, beginning of year 1,262,606 7,662,712 8,925,318 Net Assets, end of year $ 1,018,092 $ 12,017,795 $ 13,035,887 See accompanying notes to the consolidated financial statements. 5

8 CONSOLIDATED STATEMENT OF FUNCTIONAL EXPENSES Program Services Management and General Fundraising Total Personnel Expenses Staff employees Salaries $ 4,481,419 $ 861,639 $ 325,986 $ 5,669,044 Payroll taxes and employee benefits 1,115, ,386 66,910 1,365,890 5,597,013 1,045, ,896 7,034,934 Stipend employees Salaries 143, ,305 Payroll taxes and employee benefits 29, , , ,816 Total Personnel Expenses 5,769,829 1,045, ,896 7,207,750 Other Expenses Auto and equipment leases 122,133 15,794 6, ,541 Bad debt expense - 38,302-38,302 Bank charges and late fees - 27,240-27,240 Donations 15, ,000 Depreciation and amortization 276,671 27, ,165 Dues and subscriptions 6,601 30,519 2,547 39,667 Fundraising, advertising, and recruiting 8, ,896 11,367 Insurance 147,399 6,713 2, ,513 Interest 104, ,955 Miscellaneous 3,639 13,241-16,880 Office equipment 59,084 3,293 1,628 64,005 Office supplies 35,248 7,154 9,680 52,082 Postage, shipping, and courier services 10, ,324 16,006 Printing 3, ,987 15,137 Professional fees 557, , , ,757 Program supplies 296, , ,812 Rent 605,831 23,100 55, ,927 Repairs and maintenance 181, ,376 Sales related expenses 146, ,109 Staff training and development 12,266 44,826 2,141 59,233 Taxes and licenses 14, ,280 Telephone and internet 135,595 5,415 4, ,443 Transportation 210,842 20,784 4, ,448 Utilities and alarm 170,936 4, ,687 $ 8,896,436 $ 1,472,777 $ 615,469 $ 10,984, % 13.4% 5.6% 100.0% See accompanying notes to the consolidated financial statements. 6

9 CONSOLIDATED STATEMENT OF CASH FLOWS Cash Flows from Operating Activities Changes in net assets $ 4,110,569 Adjustments to reconcile changes in net assets to net cash provided by operating activities Depreciation and amortization 304,165 Realized gains on sales of investments (59,151) Allowance for doubtful accounts 36,000 Equity in income of unconsolidated limited partnerships (1,222) Deferred interest on long-term debt 81,890 (Increase) decrease in operating assets Accounts receivable (324,341) Pledges receivable 7,000 Prepaid expenses and other current assets (2,053) Deposits 15,460 Increase (decrease) in operating liabilities Accounts payable and accrued expenses (46,959) Deferred revenue 500,631 Accrued unemployment (12,109) Tenant security deposit liabilities 9,421 DMH liability (50,971) Net Cash Provided by Operating Activities 4,568,330 Cash Flows from Investing Activities Purchases of property and equipment (4,277,381) Deposits to and interest earned on restricted deposits and funded reserves (336,749) Withdrawals from restricted deposits and funded reserves 394,081 Purchases of investments (179,836) Proceeds from sales of investments 1,141,525 Net Cash Used in Investing Activities (3,258,360) See accompanying notes to the consolidated financial statements. 7

10 CONSOLIDATED STATEMENT OF CASH FLOWS Cash Flows from Financing Activities Payments on line of credit $ (128,283) Payments of long-term debt (98,433) Advances of long-term debt 75,241 Net Cash Used in Financing Activities (151,475) Net Increase in Cash and Cash Equivalents 1,158,495 Cash and Cash Equivalents, beginning of year 322,124 Cash and Cash Equivalents, end of year $ 1,480,619 SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Cash Paid during the Year for Interest $ 23,065 See accompanying notes to the consolidated financial statements. 8

11 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 - NATURE OF OPERATIONS Step Up On Second Street, Inc. ("SUOSS, Inc."), a California tax-exempt nonprofit corporation, was formed on July 1, 1986, to provide quality housing, educational, vocational, case management, socialization, and advocacy services to adults in recovery from severe and persistent mental illnesses, so they can become productive members of the community. SUOSS, Inc.'s principal funding is from the County of Los Angeles Department of Mental Health. Other support is provided by federal, state and local governments, corporate and foundation grants, and charitable gifts provided by individuals. In order to fulfill its mission, SUOSS, Inc. has formed several subsidiary limited partnerships and limited liability companies (the "Subsidiaries"). In November 1992, SUOSS, Inc. formed Step Up on Second, L.P. ("SUOS LP") to build and operate an affordable housing project for low-income households in Santa Monica, California. SUOSS, Inc. is the general partner of SUOS LP. Subsequently, in November 2009, SUOSS, Inc. formed Step Up on Second, LLC ("SUOS LLC") (a Single Member LLC [SMLLC]) to serve as the limited partner of SUOS LP. In December 2004, SUOSS, Inc. formed Step Up on Fifth, L.P ("SUOF LP") to build and operate an affordable housing project for low-income families in Santa Monica, California. SUOSS, Inc. is a non-managing general partner of SUOF LP. In May 2009, SUOSS, Inc. formed Daniel's Village, LLC ("DV LLC") (a SMLLC) to build and operate permanent housing for low and very low-income households in Santa Monica, California. In March 2011, SUOSS, Inc. formed Michael's Village, LLC ("MV LLC") (a SMLLC) to build and operate permanent housing for homeless persons with mental illness in Hollywood, California. At June 30, 2016, the assets, liabilities, and results of operations for Michael's Village are included in the books and records of SUOSS, Inc. Management plans to transfer all financial assets, liabilities, and results of operations for Michael's Village into MV LLC during the year ending June 30, In March 2011, SUOSS, Inc. formed Step Up on Vine, L.P. ("SUOV LP") to build and operate permanent housing for homeless persons with mental illness in Los Angeles, California. Subsequently, in November 2011, SUOSS, Inc. formed Step Up on Vine, LLC ("SUOV LLC") to serve as the general partner of SUOV LP. SUOSS, Inc. is a nonmanaging member of SUOV LLC. 9

12 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 - NATURE OF OPERATIONS (Continued) In January 2012, SUOSS, Inc. formed Step Up on Colorado, L.P. ("SUOC LP") to build and operate an affordable housing project for low-income families in Santa Monica, California. Also in January 2012, SUOSS, Inc. formed Step Up on Colorado, LLC ("SUOC LLC") to serve as the general partner of SUOC LP. SUOSS, Inc. is a nonmanaging member of SUOC LLC. In May 2012, SUOSS, Inc. formed The Tammy Apartments, LLC ("TTA LLC") (a SMLLC) to build and operate permanent housing for homeless persons with mental illness in Los Angeles, California. In August 2014, SUOSS, Inc. formed Step Up on Bromont, LLC ("SUOB LLC") (a SMLLC). This entity was dissolved on July 8, In October 2014, SUOSS, Inc. formed Step Up on Vine Cafe, LLC ("SUOVC LLC") (a SMLLC) to operate a cafe at Step Up on Vine. Management plans to dissolve SUOVC LLC during the year ending June 30, In February 2015, SUOSS, Inc. formed Family Centered Housing, LLC ("FCH LLC") (a SMLLC) in order to provide a privatized housing and services solution for families with adult children struggling with mental illness who had nowhere to turn for help for housing for their adult children. This entity explored options to create a housing solution for families who had no real options to secure housing on their own. This entity had minimal activity and was dissolved on July 8, In March 2016, SUOSS, Inc. formed Step Up on 26th, LLC ("SUO26TH LLC") (a SMLLC) in order acquire, rehabilitate, and operate affordable multifamily housing in Santa Monica, California. NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Consolidation The accompanying consolidated financial statements include the accounts of SUOSS, Inc., and its affiliates SUOS LP, SUOS LLC, DV LLC, TTA LLC, MV LLC, SUOVC LLC, FCH LLC, SUO26TH LLC. Collectively, SUOSS, Inc. and these affiliates are referred to as the "Organization." All significant inter-company transactions and balances have been eliminated in consolidation. 10

13 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Basis of Consolidation (Continued) SUOF LP, SUOV LP, and SUOC LP are not controlled by SUOSS, Inc. and the assets, liabilities, and results of operations are not included in the accompanying consolidated financial statements but are recognized using the equity method of accounting. Income Tax Status SUOSS, Inc. is a nonprofit public benefit corporation organized under the laws of California and, as such, is exempt from federal and state income taxes under Internal Revenue Code ("IRC") Section 501(c)(3) and corresponding state provisions. SUOS LLC, DV LLC, TTA LLC, MV LLC, SUOVC LLC, FCH LLC, and SUO26TH LLC are SMLLC's which are deemed to be disregarded entities for income tax purposes. SUOS LP is a limited partnership between SUOS LLC and SUOSS, Inc. Accordingly, all earnings, gains, and losses of the SMLLC's and SUOS LP are passed through to their respective member, SUOSS, Inc. No taxes or fees are payable for federal income tax purposes. For California, each LLC and LP is required to pay a fee based on gross receipts, as defined, plus $800 annually. The Organization's federal income tax and informational returns for tax years ended June 30, 2013, and subsequent remain subject to examination by the Internal Revenue Service. The returns for California, the Organization's only state tax jurisdiction, remain subject to examination by the California Franchise Tax Board for tax years ended June 30, 2012, and subsequent. Financial Statement Presentation The Organization reports information regarding its financial position and activities according to three classes of net assets: unrestricted, temporarily restricted and permanently restricted. Unrestricted Net Assets - Include grants, contributions, rents, fees, sales and other forms of revenue that are not restricted by the donor or grantor as well as expenditures related to the general operations of the Organization. 11

14 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Financial Statement Presentation (Continued) Temporarily Restricted Net Assets - Include contributions and grants that are temporarily restricted by the donor or grantor or time restricted to the extent they will be collected or expended in the future. When the donor or time restriction has been met, the net assets of this classification are reclassified to unrestricted net assets. Restricted contributions where restrictions are met in the same reporting period are classified as unrestricted. Permanently Restricted Net Assets - Include contributions that have been restricted by the donor in perpetuity. There were no permanently restricted net assets at June 30, Use of Estimates Management uses estimates and assumptions in preparing consolidated financial statements. Those estimates and assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported revenues and expenses. Actual results could differ from these estimates. Cash and Cash Equivalents The Organization considers financial instruments with original maturities of 90 days or less to be cash equivalents. Cash Held-in-Trust The Organization maintains bank accounts, segregated from the Organization's assets, for cash held-in-trust for certain program participants. At June 30, 2016, the amount of such funds held-in-trust totaled $33,260. Balances in such accounts are FDIC-insured up to the applicable limits. Investments Investments are monitored by the Board of Directors and are stated at fair value. Unrealized gains and losses are recognized aggregately. Realized gains and losses are recognized immediately and are computed using the specific identification method. As of June 30, 2016, all investments held by the Organization had been liquidated. 12

15 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Accounts Receivable Accounts receivable are unsecured and the Organization is at-risk to the extent that such amounts become uncollectible. The Organization uses the allowance method for uncollectible accounts receivable. The allowance for doubtful accounts as of June 30, 2016 was $36,000. Property and Equipment Purchases of property and equipment are recorded at cost. Donated items are recorded at fair value when received. Depreciation and amortization on both purchased and donated items are recorded using the straight-line method over the shorter of the estimated useful life of the related asset or the term of the lease for leasehold improvements as follows: Building Leasehold improvements Equipment 27.5 years 27.5 years 3-7 years Normal repairs and maintenance are expensed as incurred, whereas significant charges that materially increase values or extend useful lives are capitalized and depreciated over the estimated useful lives of the related assets. Impairment of Long-Lived Assets Management reviews each asset or asset group for impairment whenever events or circumstances indicate that the carrying value of an asset or asset group may not be recoverable, but at least annually. No impairment provision was recorded by the Organization during the year. Deferred Revenue The Organization receives cash flow advances as part of its contracts with Los Angeles County Department of Mental Health ("DMH"). Advances received in excess of revenue recognized are presented as a deferred revenue liability on the consolidated statement of financial position. 13

16 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) DMH Liability The Organization maintains multiple contracts with DMH to provide program services to qualified clients. DMH will pay the Organization for services upon billing; however, the claims remain open until a later date at which time DMH can reconcile the billings and close the contract year. As a result, a potential liability exists for historical billings. Contract years can remain open for up to seven years. The Organization has established a separate accrual line item related to open contract years totaling $313,669 as of June 30, 2016, based on preliminary audit communications provided by DMH. Contributed Goods and Services Donations of merchandise to the Organization, primarily consisting of used clothing, are not recorded as revenue due to the inability to estimate the fair value when received. The Organization also receives many hours of donated volunteer time; no amounts have been reflected in the accompanying consolidated financial statements for these contributed services, as the value of these services does not meet the criteria for recording established by U.S. GAAP. Functional Expenses The Organization allocates its expenses on a functional basis among its various programs and support services. Expenses that can be identified with a specific program or support service are allocated directly according to their natural expense classification. Other expenses that are common to several functions are allocated accordingly. Concentration of Credit Risk Occasionally, the Organization's cash balances exceed FDIC-insured limits. The Organization has not experienced and does not anticipate any losses related to these balances. The Organization has one major funding source that comprised approximately 63% of its contract and grant revenue during the year and 53% of its accounts receivable at June 30,

17 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) Subsequent Events The Organization has evaluated events subsequent to June 30, 2016, to assess the need for potential recognition or disclosure in the consolidated financial statements. Such events were evaluated through March 29, 2017, the date the consolidated financial statements were available to be issued. Based upon this evaluation, it was determined no subsequent events occurred that require recognition or additional disclosure in the consolidated financial statements, except as disclosed in Notes 1 and 10. NOTE 3 - INVESTMENTS Activity in the investments during the year was as follows: Balance, beginning of year $ 902,538 Purchases of investments 179,836 Proceeds from sales of investments (1,141,525) Realized gains on sales of investments 59,151 Balance, end of year $ - Investment income during the year is comprised of the following: Interest and dividends, net of fees $ 6,719 Realized gains on sale of investments 59,151 $ 65,870 15

18 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS NOTE 4 - ACCOUNTS RECEIVABLE Accounts receivable consist of the following: Accounts receivable $ 1,411,902 Developer fees and other receivables 70,174 Rents receivable 61,814 1,543,890 Allowance for doubtful accounts (36,000) $ 1,507,890 NOTE 5 - RESTRICTED DEPOSITS AND FUNDED RESERVES Restricted deposits and funded reserves consist of the following: Tenant Deposits Held in Trust The Organization is required to maintain separate cash accounts for tenants' rental security deposits, totaling $43,778 at June 30, Replacement Reserves The Organization is required to maintain and make regular deposits to replacement reserves in accordance with provisions of regulatory agreements with various funding agencies. The replacement reserves are to be used for the replacement of property and equipment and generally require the prior approval of the applicable regulatory agency. Replacement reserves totaled $284,005 at June 30, Operating Reserves The Organization is required to maintain and make regular deposits to operating reserves in accordance with provisions of regulatory agreements with various funding agencies. The operating reserves are to be used for operating expenses as defined in the applicable regulatory agreements. Operating reserves totaled $62,481 at June 30,

19 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS NOTE 5 - RESTRICTED DEPOSITS AND FUNDED RESERVES (Continued) Tax Assessment and Insurance Reserves The Organization is required to maintain and make regular deposits to tax assessment and insurance reserves in accordance with provisions of regulatory agreements with various funding agencies. The tax assessment and insurance reserves are to be used for tax and insurance premiums as defined in the applicable regulatory agreements. Tax assessment and insurance reserves totaled $47,385 at June 30, Reserves Held By Agency Based upon the terms of the Regulatory Agreement between DV LLC and the Redevelopment Agency of the City of Santa Monica ("SM RA"), $26,247 is held by SM RA for a Supplemental Capitalized Operating Subsidy Reserve ($52) and an Operating Expense Reserve ($26,195). These reserve funds were held back as a condition of the $733,810 loan payable to SM RA (see Note 10), until such time as the use of the funds is approved to be released for certain operating expenses and other costs, as defined in the regulatory agreement. The California Housing Finance Agency ("CHFA") has set aside a Capitalized Operating Subsidy Reserve in the amount of $737,315 (including accumulated interest) to be used to subsidize operating costs of the MHSA (Mental Health Services Act) units of Daniel's Village, LLC. This reserve has not been recorded on the books of DV LLC, as it is a subsidy to be received only upon meeting certain operating loss contingencies, as defined in the CHFA regulatory agreement. 17

20 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS NOTE 6 - NOTES RECEIVABLE FROM UNCONSOLIDATED RELATED PARTIES Notes receivable from unconsolidated related parties consist of the following: Note receivable from SUOF LP, non-interest-bearing, secured by a subordinated deed of trust on the SUOF LP real property, and due January $ 230,000 Note receivable from SUOF LP, non-interest-bearing, secured by a subordinated deed of trust on the SUOF LP real property, and due January ,500,000 Note receivable from SUOV LP, non-interest-bearing, unsecured, and due 30 years after the Construction Period Maturity Date occurs upon receipt of the completion of construction. 253,484 $ 1,983,484 NOTE 7 - INVESTMENTS IN UNCONSOLIDATED LIMITED PARTNERSHIPS The Organization records investments in unconsolidated partnerships using the equity method of accounting. Investments in unconsolidated limited partnerships are as follows: SUOV LP $ 763,828 SUOF LP 12,532 SUOC LP 89 $ 776,449 18

21 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS NOTE 8 - PROPERTY AND EQUIPMENT Property and equipment consists of the following: Land $ 8,959,791 Buildings 7,679,146 Leasehold improvements 1,017,510 Equipment 605,239 18,261,686 Less accumulated depreciation and amortization (3,952,034) $ 14,309,652 NOTE 9 - ACCRUED UNEMPLOYMENT LIABILITY The Organization has elected to be self-insured for purposes of California state unemployment insurance and has established a provision for future claims in the amount of $133,357 as of June 30, Unemployment claims totaled $41,598 for the year. NOTE 10 - LONG-TERM DEBT Long-term debt is detailed as follows: Note payable by SUOSS, Inc. to Bank of America through the Federal Home Loan Bank Affordable Housing Program ("FHLB AHP"), secured by a subordinated deed of trust on the real property of SUOF LP, non-interest-bearing, due January 2064 (see Note 6). $ 230,000 Note payable by Daniel's Village to California Housing Finance Agency ("CHFA"), secured by a first deed of trust on the real property of Daniel's Village, payable in annual installments to the extent of 26.7% of Residual Receipts (as defined in the CHFA Regulatory Agreement), applied first to interest at 3% per annum, then to principal, through October 2064, at which time all outstanding principal and interest are due. Accrued interest totaled $148,777 as of June 30, ,810 19

22 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS NOTE 10 - LONG-TERM DEBT (Continued) Note payable by TTA, LLC to a private lender, secured by a first deed of trust on the real property of TTA LLC, with interest-only payments due quarterly at 1.875% per annum, due December As of March 29, 2017, management is in discussions with the lender to extend the note. No principal payments are anticipated to be made in the fiscal year ending June 30, Annual principal payments subsequent to June 30, 2017, are estimated to be $25, ,000 Note payable by SUOSS, Inc. to a private lender, secured by a first deed of trust on the real property of MV LLC, with interest at 3% per annum, due June Accrued interest totaled $180,000 at June 30, ,000,000 Note payable by SUOSS, Inc. to the City of Los Angeles, secured by the City Deed of Trust on the real property of MV LLC, noninterest-bearing, payable in annual installments to the extent of 29.56% of Residual Receipts (as defined in the CHFA Regulatory Agreement), through May ,301,307 Subtotal, note principal 5,025,117 Deferred interest 328,777 $ 5,353,894 Future scheduled maturities of long-term debt are as follows: Year Ending June 30, Principal Deferred Interest Total 2017 $ - $ - $ ,000-25, ,000-25, ,000-25, ,000-25,000 Thereafter 4,925, ,777 5,253,894 $ 5,025,117 $ 328,777 $ 5,353,894 20

23 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS NOTE 10 - LONG-TERM DEBT (Continued) In October 2016, the Organization received a $500,000 program-related investment loan from the Weingart Foundation. The loan is intended to provide working capital to bridge potential cash flow needs while the Organization expands its permanent supportive housing model and services to San Bernardino, California. The loan is unsecured, earns interest at 3% per annum, payable quarterly through December 2018, at which time all interest and principal is due. NOTE 11 - COMMITMENTS The Organization has noncancelable operating leases for office, program facilities, and equipment. Rent expense relating to these leases totaled $829,468 for the year. The scheduled minimum lease payments under the lease terms are as follows: Year Ending June 30, 2017 $ 622, , , ,716 $ 1,580,720 NOTE 12 - CONTINGENCIES The Organization is contingently liable under several contingent promissory notes and grant agreements. These contingent promissory notes and grant agreements have not been recorded as liabilities on the consolidated statement of financial position as repayment is not required as long as the Organization continues to own the properties which secure the notes and complies with the provisions of the respective notes, grants and regulatory agreements, which it fully intends to do. Accordingly, any related accrued interest has not been recorded. The contingent promissory notes and grant agreements have been reflected as temporarily restricted net assets (see Note 13). 21

24 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS NOTE 12 - CONTINGENCIES (Continued) Contingent Grant Agreements Terms and descriptions of the contingent grant agreements are as follows: Contingent non-interest-bearing unsecured grant agreement to SUOSS, Inc. by the Community Development Commission of the County of Los Angeles ("LA CDC"). The grant agreement between SUOSS, Inc. and LA CDC requires SUOSS, Inc. to operate the SUOV LP real property to provide permanent housing for homeless persons with mental illness for a period of at least 15 years through November For as long as SUOSS, Inc. and SUOV LP comply with the provisions of the grant agreement with LA CDC, the outstanding contingent balance ($142,858 as of June 30, 2016) will be reduced by annual $35,714 service credits through March Contingent non-interest-bearing unsecured grant agreement to SUOSS, Inc. by LA CDC. The grant agreement between SUOSS, Inc. and LA CDC requires SUOSS, Inc. to operate the Michael's Village real property to provide permanent housing for homeless persons with mental illness for a period of at least 15 years through April For as long as SUOSS, Inc. and MV LLC comply with the provisions of the grant agreement with LA CDC, the outstanding contingent balance ($571,428 as of June 30, 2016) will be reduced by annual $114,286 service credits through January Contingent non-interest-bearing unsecured grant agreement to TTA LLC by LA CDC. The grant agreement between TTA LLC and LA CDC requires TTA LLC to operate the TTA LLC real property to provide permanent housing for homeless persons with mental illness for a period of at least 15 years through April For as long as TTA LLC complies with the provisions of the grant agreement with LA CDC, the outstanding contingent balance ($142,858 as of June 30, 2016) will be reduced by annual service credits of $35,714 through April Contingent non-interest-bearing grant agreement to SUOSS, Inc. by Los Angeles Homeless Services Authority ("LAHSA") in the amount of $400,000, secured by a third deed of trust on the real property of MV LLC. The capital agreement between SUOSS, Inc. and LAHSA requires MV LLC to operate the property to provide permanent housing to low-income households. For as long as MV LLC complies with the provisions of its capital agreement with LAHSA, payments on the balance of this note will be deferred until May 2023, at which time the then-outstanding contingent balance ($400,000 as of June 30, 2016) will be reduced by annual service credits equal to 10% of the thenoutstanding contingent balance through May

25 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS NOTE 12 - CONTINGENCIES (Continued) Contingent Promissory Notes Terms and descriptions of the contingent promissory notes are as follows: Two contingent promissory notes payable by SUOS LP to SM RA, secured by a first deed of trust on the real property of SUOS LP. The regulatory agreement between SUOS LP and SM RA requires SUOS LP to operate the property to provide housing to lowincome households. For as long as SUOS LP complies with the provisions of its regulatory agreement with SM RA, the principal and interest payments on the balance of these notes and any corresponding interest will be deferred until November 2065 (extendable until November 2090), except as follows: to the extent the property has Residual Receipts (as defined in the SM RA regulatory agreement) in any given year, 50% of the Residual Receipts, if any, must be paid as a contingent liability, applied first to accumulated interest on the contingent promissory notes and then to principal through November In November 2090, all principal ($3,510,317 as of June 30, 2016) plus any unpaid interest, calculated at 4.57% per annum, compounded annually ($821,158 as of June 30, 2016), will be forgiven; the City of Santa Monica holds an option to purchase the property in November 2090 for $1. Contingent promissory note payable by DV LLC to SM RA, secured by a first deed of trust on the real estate of DV LLC. The regulatory agreement between DV LLC and SM RA requires DV LLC to operate the property to provide permanent housing to low and very-low income households. For as long as DV LLC complies with the provisions of its regulatory agreement with SM RA, the principal and interest payments on the balance of this note and any corresponding interest will be deferred until October 2062 (extendable until October 2087), except as follows: to the extent the property has Residual Receipts (as defined in the SM RA regulatory agreement) in any given year, half of 73.3% of the Residual Receipts, if any, must be paid as a contingent liability, applied first to accumulated interest on the contingent promissory note and then to principal through October In October 2087, all principal ($2,018,162 as of June 30, 2016) plus any unpaid interest, calculated at 6.37% per annum, compounded annually ($1,054,603 as of June 30, 2016), will be forgiven. Contingent non-interest-bearing promissory note payable by SUOSS, Inc. to Union Bank through the FHLB AHP in the amount of $500,000, secured by a fifth deed of trust on the real property of MV LLC. The loan agreement between SUOSS, Inc. and Union Bank requires MV LLC to operate the property to provide permanent housing to low income households. For as long as MV LLC complies with the provisions of its loan agreement with Union Bank, all principal payments on the balance of this note will be deferred until December 2067, at which time the then-outstanding contingent balance ($500,000 as of June 30, 2016) will be forgiven. 23

26 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS NOTE 12 - CONTINGENCIES (Continued) Contingent Promissory Notes (Continued) Contingent promissory note payable by SUO26TH LLC to the City of Santa Monica ("SM"), secured by a first deed of trust on the real estate of SUO26TH LLC. The regulatory agreement between SUO26TH LLC and SM requires SUO26TH LLC to operate the property to provide affordable multifamily housing to low and very-low income households. For as long as SUO26TH LLC complies with the provisions of its regulatory agreement with SM, the principal and interest payments on the balance of this note and any corresponding interest will be deferred until April 2066 (extendable until April 2091), except as follows: to the extent the property has Residual Receipts (as defined in the SM regulatory agreement) in any given year, half the Residual Receipts, if any, must be paid as a contingent liability, applied first to accumulated interest on the contingent promissory note and then to principal through April In April 2091, all principal and any unpaid interest, calculated at 3.58% per annum, compounded annually ($26,512 as of June 30, 2016), will be forgiven. As of June 30, 2016, the Organization had $4,300,000 outstanding on the conditional promissory note with an additional $2,056,000 available to the Organization for qualified withdrawals. The principal of these contingent promissory notes has been recorded as temporarily restricted net assets upon receipt of the advances. The accrued interest on these contingent promissory notes, while reported as a contingent liability in these notes, has not been recorded by the Organization; thus they are not included in temporarily restricted net assets. 24

27 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS NOTE 13 - TEMPORARILY RESTRICTED NET ASSETS Temporarily restricted net assets and releases during the year are as follows: Released from Restrictions Balance, June 30, 2016 Conditional promissory notes payable to SM RA $ - $ 5,528,479 Conditional promissory note payable to SM - 4,300,000 Conditional grants from LA CDC 185, ,144 Conditional promissory note payable to Union Bank - 500,000 Conditional grant from LAHSA - 400,000 Weingart - administrative 187, ,875 The Carl & Roberta Deutsch Foundation 30,000 80,000 The Angell Foundation -Vine meal program 50,000 50,000 Annenberg Foundation 66,667 33,333 United Way - pledge receivable 29,286 25,714 Saint John's Health Center 15,000 15,000 Specialty Family Foundation 18,750 6,250 Julie's room gifts - art supplies 7,000 - The Rose Hills Foundation - Hollywood 25,000 - $ 614,917 $ 12,017,795 NOTE 14 - EMPLOYEE BENEFIT PLANS The Organization offers an IRC Section 403(b) for all eligible employees. The 403(b) plan is a non-erisa plan. Participants may make annual contributions up to the maximum allowable deferral amount for defined contribution plans. 25

28 CONSOLIDATING INFORMATION 26

29 INDEPENDENT AUDITOR'S REPORT ON CONSOLIDATING INFORMATION Board of Directors STEP UP ON SECOND STREET, INC. Santa Monica, California We have audited the consolidated financial statements of Step Up On Second Street, Inc. as of and for the year ended June 30, 2016, and have issued our report thereon dated March 29, 2017, which expressed an unmodified opinion on those consolidated financial statements and appears on page 1. Our audit was conducted for the purpose of forming an opinion on the consolidated financial statements as a whole. The consolidating information on pages is presented for purposes of additional analysis of the consolidated financial statements rather than to present the financial position, results of operations, and cash flows of the individual companies, and it is not a required part of the consolidated financial statements. Such information is the responsibility of management and was derived from and relates directly to the underlying accounting and other records used to prepare the consolidated financial statements. The consolidating information has been subjected to the auditing procedures applied in the audit of the consolidated financial statements and certain additional procedures, including comparing and reconciling such information directly to the underlying accounting and other records used to prepare the consolidated financial statements or to the consolidated financial statements themselves, and other additional procedures in accordance with U.S. GAAS. In our opinion, the consolidating information is fairly stated in all material respects in relation to the consolidated financial statements as a whole. March 29, 2017 Armanino LLP Los Angeles, California

30 CONSOLIDATING STATEMENTS OF FINANCIAL POSITION JUNE 30, 2016 Step Up On Second Street, Inc* Step Up on Second Daniel's Village ASSETS The Tammy Apartments Family Centered Housing Step Up On 26th Street Step Up On Vine Cafe Eliminating Entries Consolidated Current Assets Cash and cash equivalents $ 1,118,846 $ 206,510 $ 590 $ 7,269 $ - $ 93,737 $ 53,667 $ - $ 1,480,619 Accounts receivable, net 1,385,946 8,706 40,953 6,728-1,327 64,230-1,507,890 Prepaid expenses and other current assets 31, ,343 2,536, ,716 41,775 13,997-95, ,897-3,020,852 Other Assets Restricted deposits and funded reserves 24, ,086 48,147 7, ,896 Due from related parties 1,370, , , (1,737,138) - Notes receivable from unconsolidated related parties 1,983, ,983,484 Investments in limited partnerships 9,317, (8,541,029) 776,449 Property and equipment, net 4,440,979 2,383,467 2,328, ,484-4,205,096 7,187-14,309,652 Deferred financing costs, net Deposits 84, ,069 17,220,740 3,108,925 2,376, ,542 26,258 4,205,096 7,187 (10,278,167) 17,618,167 $ 19,757,143 $ 3,324,641 $ 2,418,361 $ 965,539 $ 26,258 $ 4,300,160 $ 125,084 $ (10,278,167) $ 20,639,019 *The balances of Step Up On Second Street, Inc. include the activities of Michael's Village. See accompanying independent auditor's report. 28

31 CONSOLIDATING STATEMENTS OF FINANCIAL POSITION JUNE 30, 2016 Step Up On Second Street, Inc* Step Up on Second LIABILITIES AND NET ASSETS Daniel's Village The Tammy Apartments Family Centered Housing Step Up On 26th Street Step Up On Vine Cafe Eliminating Entries Consolidated Current Liabilities Accounts payable and accrued expenses $ 825,974 $ 6,367 $ 25,091 $ 502 $ 25,000 $ 15,000 $ 42,266 $ - $ 940,200 Deferred revenue 813, ,904 DMH liability 313, ,669 Accrued unemployment 133, ,357 2,086,080 6,858 25, ,000 15,000 42,266-2,201,130 Long-Term Liabilities Long-term debt, net of current portion 3,711, , , ,353,894 Tenant security deposit liabilities 21,886 11, ,715-1, ,108 Due to related parties 901,983 3, ,102 36, ,783 (1,737,138) - 4,635,176 14,835 1,557, ,786-1, ,783 (1,737,138) 5,402,002 Total Liabilities 6,721,256 21,693 1,582, ,499 25,000 16, ,049 (1,737,138) 7,603,132 Commitments and Contingencies(Notes 11 and 12) Net Assets Unrestricted 1,018,092 (207,369) (1,182,574) 13,183 1,258 (15,840) (38,965) 1,430,307 1,018,092 Temporarily restricted 12,017,795 3,510,317 2,018, ,857-4,300,000 - (9,971,336) 12,017,795 Total Net Assets 13,035,887 3,302, , ,040 1,258 4,284,160 (38,965) (8,541,029) 13,035,887 $ 19,757,143 $ 3,324,641 $ 2,418,361 $ 965,539 $ 26,258 $ 4,300,160 $ 125,084 $ (10,278,167) $ 20,639,019 *The balances of Step Up On Second Street, Inc. include the activities of Michael's Village. See accompanying independent auditor's report. 29

32 CONSOLIDATING STATEMENTS OF ACTIVITIES Step Up On Second Street, Inc* Step Up on Second Daniels Village, LLC The Tammy Apartments, LLC Family Centered Housing Step Up On 26th Street Step Up On Vine Cafe Eliminating Entries Consolidated Revenues Contracts and grants $ 8,573,919 $ - $ 56,664 $ - $ - $ - $ 274,111 $ - $ 8,904,694 Housing grant ,300, ,300,000 Contributions 1,151, ,151,238 Rental income 283, ,022 24, ,416-15,376 - (50,000) 686,537 Miscellaneous 186,636 6,780 3, , ,680 DMH adjustment to closed contract years (276,845) (276,845) Equity in net income of consolidated subsidiaries 3,975, (3,975,184) - Equity in income of unconsolidated limited partnerships 1, ,222 13,895, ,802 84, ,416-4,315, ,263 (4,025,184) 14,984,526 Functional Expenses Personnel expenses 6,852,790 83,909 73,096 32, ,681-7,207,750 Other functional expenses 3,039, , , ,010-31, ,647 (50,000) 3,776,932 9,892, , , ,284-31, ,328 50,000 10,984,682 Changes in Net Assets from Operations 4,003,036 (79,917) (145,318) (47,868) - 4,284,160 (39,065) (3,975,184) 3,999,844 *The balances of Step Up On Second Street, Inc. include the activities of Michael's Village. See accompanying independent auditor's report. 30

33 CONSOLIDATING STATEMENTS OF ACTIVITIES Step Up On Second Street, Inc* Step Up on Second Daniels Village, LLC The Tammy Apartments, LLC Family Centered Housing Step Up On 26th Street Step Up On Vine Cafe Eliminating Entries Consolidated Changes in Net Assets from Operations (from previous page) $ 4,003,036 $ (79,917) $ (145,318) $ (47,868) $ - $ 4,284,160 $ (39,065) $ (3,975,184) $ 3,999,844 Other Changes in Net Assets Investment income, net of fees 62, , ,870 Insurance recovery 44, ,855 Total Other Changes in Net Assets 107, , ,725 Changes in Net Assets 4,110,569 (79,650) (142,393) (47,868) - 4,284,160 (39,065) (3,975,184) 4,110,569 Net Assets, beginning of year 8,925,318 3,382, , ,908 1, (4,565,845) 8,925,318 Net Assets, end of year $ 13,035,887 $ 3,302,948 $ 835,588 $ 156,040 $ 1,258 $ 4,284,160 $ (38,965) $ (8,541,029) $ 13,035,887 *The balances of Step Up On Second Street, Inc. include the activities of Michael's Village. See accompanying independent auditor's report. 31

34 SINGLE AUDIT REPORTS AND SCHEDULES

35 INDEPENDENT AUDITOR'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING AND ON COMPLIANCE AND OTHER MATTERS BASED ON AN AUDIT OF FINANCIAL STATEMENTS PERFORMED IN ACCORDANCE WITH GOVERNMENT AUDITING STANDARDS Board of Directors STEP UP ON SECOND STREET, INC. Santa Monica, California We have audited, in accordance with the U.S. GAAS and the standards applicable to financial audits contained in Government Auditing Standards issued by the Comptroller General of the U.S., the consolidated financial statements of Step Up On Second Street, Inc. (the "Organization") (a nonprofit organization), which comprise the consolidated statement of financial position as of June 30, 2016, and the related consolidated statements of activities, functional expenses, and cash flows for the year then ended, and the related notes to the consolidated financial statements, and have issued our report thereon dated March 29, Internal Control Over Financial Reporting In planning and performing our audit of the consolidated financial statements, we considered the Organization's internal control over financial reporting (internal control) to determine the audit procedures that are appropriate in the circumstances for the purpose of expressing our opinion on the consolidated financial statements, but not for the purpose of expressing an opinion on the effectiveness of the Organization's internal control. Accordingly, we do not express an opinion on the effectiveness of the Organization's internal control. Our consideration of internal control was for the limited purpose described in the preceding paragraph and was not designed to identify all deficiencies in internal control that might be material weaknesses or significant deficiencies and therefore, material weaknesses or significant deficiencies may exist that were not identified. However, as described in the accompanying schedule of findings and questioned costs, we identified certain deficiencies in internal control that we consider to be material weaknesses and significant deficiencies. A deficiency in internal control exists when the design or operation of a control does not allow management or employees, in the normal course of performing their assigned functions, to prevent, or detect and correct, misstatements on a timely basis. A material weakness is a deficiency, or a combination of deficiencies, in internal control, such that there is a reasonable possibility that a material misstatement of the Organization's consolidated financial statements will not be prevented, or detected and corrected, on a timely basis. We consider the deficiency described in Finding in the accompanying schedule of findings and questioned costs to be a material weakness. A significant deficiency is a deficiency, or a combination of deficiencies, in internal control that is less severe than a material weakness, yet important enough to merit attention by those charged with governance. We consider the deficiency described in Finding in the accompanying schedule of findings and questioned costs to be a significant deficiency.